Tuesday, October 07, 2008

Who'd have imagined this? - a cut of 1.00 percentage points, when all of the last 16 moves have been by 0.25 percentage points.

The Reserve Bank makes clear in its statement that, as it sees things now, today's big cut is a one-off:

"The recent deterioration in prospects for global growth, together with much more difficult market conditions even for creditworthy borrowers, now present the risk that demand and output could be significantly weaker than earlier expected. Should that occur, inflation would most likely fall faster than earlier forecast."

..the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers. The Board does not, however, regard that movement as establishing a pattern for future decisions."

Will it be enough to avert a domestic credit crisis and a recession?

If it is not, the Reserve Bank will do more.

With our cash rate still high at 6.00% Australia - unlike most other developed countries - has plenty of room to cut further.

We have a better chance of avoiding a a domestic credit crisis and a recession than just about anyone else.

Below the fold is instant analysis from the ANZ and CommSec, and below that the Reserve Bank statement in full:ANZ:

"The RBA has today slashed official cash rates by 100bp to 6.0%. This is the biggest interest rate cut done at a single meeting since May 1992 (when the Australian economy was in deep recession).

The RBA's big move today is based on (1) the view that the global (and thus local) outlook has deteriorated significantly in the last month and (2) that heightened borrowing costs mean that changes in policy rates cannot be passed through in full to retail borrowers. In the RBA's own words "the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers". By cutting by 100bp today, the RBA is hopeful that at least half of this cut (i.e.. 50bp) will be passed through to the borrowers. Today the 3-month BBSW-OIS spread, which represents about one-third of Australian bank's borrowing costs, is at 82bp.

Rumours are now circulating that today's aggressive move by the RBA is the precursor for co-ordinated interest rate cuts by global central banks tonight. Given the depths of the global credit crisis, this cannot be ruled out. Apart from the Fed, the ECB and the BoE, other Central Banks that could possibly move tonight are those currently accessing the US Fed's US$ swap line - the Central Banks of Denmark, Norway, Sweden, Switzerland and Canada. Japan, which can also access this swap line, decided to keep rates on hold at its meeting today.

The much larger than expected rate cut today tells us that the RBA is willing to use the interest rate tool to ward off emerging downside risks to the economic outlook. At the very least the RBA has successfully reminded financial markets that there is plenty of scope to reduce rates in Australia and thus minimise the negative effects of a global downturn on the domestic economy. This has seen the equity market bounce strongly after the announcement.

An easing cycle (from a position of tight policy) will have two phases - reducing the monetary restraint on the economy and then the shift towards a stimulatory stance of policy. We are still in the first stage and as such further rate reductions over the next six months are likely. Today's larger than expected move does, however, give the RBA some breathing space, which may see them sit tight over the next few months. That being said, the global economic and financial situation is moving rapidly and thus nothing can be ruled out.

Most economists would regard a cash rate of around 5.5% as a neutral policy setting. With the credit crisis pushing market funding costs up by around 50 -100bp, then a neutral cash rate maybe somewhat lower - say 4.75% to 5%. This suggests that if the RBA wants to take policy back to neutral there will be more rate cuts to come.

Best regards,
Warren Hogan and Katie Dean"

COMMSEC:

• Decisive and courageous – not words that you normally associate with the Reserve Bank but entirely appropriate.

These are desperate times, requiring desperate measures, and the Reserve Bank hasn’t been afraid to act. No doubt the Reserve Bank felt it couldn’t rely on other central banks and regulatory authorities to take decisive action to shore up their economies – it had to take up the cudgels itself.

• There’s a time to worry about inflation, but now isn’t one of them. With a global recession a 50:50 proposition, and commodity prices falling across the board, risks have now shifted in favour of deflation, not inflation. Today’s rate cut is not only appropriate in the current environment, its entirely prudent in order to extend the length of our record-breaking economic expansion.

• Ordinary Australians can be thankful that we have both a responsive and responsible central bank in the form of the Reserve Bank as well as a strong banking system. Australian banks are recording profits, not losses, and looking at making acquisitions, rather than being acquisition targets. The Reserve Bank has given the banks plenty of elbow room to cut rates so the stimulus flows through to the wider economy.

• Finally home borrowers have a reason to celebrate. And there may be even more good news down the track. A cash rate of 6 per cent still constitutes restrictive monetary policy. It is only when the cash rate gets to 5 per cent or below that the Reserve Bank is again pressing on the accelerator rather than the brakes.

• Today the Reserve Bank has removed the rate hikes delivered in November last year and February this year together with the rate increases delivered by the major banks over 2008.

• The Reserve Bank has clearly front-loaded its rate-cutting cycle in order to address negative psychology and deliver significant stimulus to the economy. The Reserve Bank rightly believed that shock treatment was necessary to change the mood and momentum of the economy.

• When a central bank cuts rates by such a large amount, the question is whether it knows something we don’t. The Reserve Bank may very well be spooked, but not by the
domestic economy, but rather the US and Europe. This may be the start of co-ordinated central bank rate action. Hopefully it will be.

Interest rate decision and past cycles

• The Reserve Bank has cut the official cash rate by 100 basis points (one percentage point) to 6.00 per cent. This was the biggest rate cut since July 1992 and follows the 25bp decline on September 2. The cash rate now stands at 6.00 per cent – the lowest since August 2006.

• Before the September rate cut there had been twelve rate hikes in the cycle extending back over five years (since May 2002), the last occurring on March 4. Over that period, rates lifted 2.75 percentage points to 7.25 per cent.

• Just like 2000/01 there was a gap of six months between the last rate hike and first rate cut. In the 2001 rate cut cycle, rates were cut by 2 percentage points in the space of 11 months (to 4.25 per cent).

• In the prior 1996/97 rate cut cycle, cash rates were cut 2.5 percentage points in 12 months, followed by another 25 basis point move just over 16 months later. The low point for interest rates was 4.75 per cent.

What are the implications for interest rates and investors?

• Initially we thought that the Reserve Bank would hasten slowly with rate cuts, but clearly we were wrong. In 2001, the Reserve Bank was forced to cut rates by 2 percentage points in the space of 11 months in response to the deterioration of the global economy, especially the US. Now with the global economy again staring down the barrel of a major slump, the Reserve Bank felt that similar dramatic action in cutting rates was required.

• Investors will have to re-assess the strategy of putting the bulk of funds in cash-based investments rather than other asset classes. Property clearly looks a much more attractive investment, especially with rents soaring and demand super-strong. Investors also need to put shares back on the radar screen. However given the on-going global risks, we still advocate a relatively defensive posture. Healthcare, utilities and consumer staples are favoured at present and diversified mining for longer-term investment.

• The Reserve Bank may not cut by 1 per cent again, but rate cuts still lie ahead. Tight monetary policy settings are not appropriate in the current environment and a cash rate of around 5.00-5.50 per cent is likely over the next 6-9 months. Neutral monetary policy is around 5.50 per cent.

• The next inflation figures won’t be a barrier to another rate cut in November. The Reserve Bank has already flagged an inflation rate of 5 per cent – but that is expected to be the peak.

Craig James, Chief Equities Economist, CommSec

STATEMENT BY GLENN STEVENS, GOVERNOR MONETARY POLICY

At its meeting today, the Board decided to lower the cash rate by 100 basis points to 6.0 per cent, effective 8 October 2008.

Conditions in international financial markets took a significant turn for the worse in September. Large-scale financial failures in several major countries were accompanied by serious dislocation in interbank markets and heightened instability in other markets, including sharp falls in share prices. Official actions in a number of countries have been aimed at restoring stability, by adding to short-term liquidity and laying a foundation for longer-term recovery in the health of balance sheets. Nonetheless, financing is likely to be difficult around the world for some time ahead. This is also affecting Australia, albeit by less than in many other countries, given the relative strength of the local banking system.

Economic activity in the major countries is also weakening, and evidence is accumulating of a significant moderation in growth in Australia’s trading partners in Asia. The expansionary effects of the recent surge in Australia’s terms of trade are still coming through, but some decline in the terms of trade now looks likely over the coming year, with many commodity prices having declined from their peaks. This, combined with the likelihood of below-trend growth in the global economy, suggests that global inflation will moderate in 2009.

Thus far, the overall path of economic activity in Australia appears to have been close to what the Board had expected, with the needed moderation in demand occurring. The next CPI is likely to show an increase of around 5 per cent over the four quarters to September, but the Bank remains of the view that inflation will start to decline in 2009.

The recent deterioration in prospects for global growth, together with much more difficult market conditions even for creditworthy borrowers, now present the risk that demand and output could be significantly weaker than earlier expected. Should that occur, inflation would most likely fall faster than earlier forecast.

Given that background, the Board judged that a material change to the balance of risks surrounding the outlook had occurred, requiring a significantly less restrictive stance of monetary policy. The Board also took careful note of movements in funding costs in wholesale markets. Having weighed these considerations, the Board decided that, on this occasion, an unusually large movement in the cash rate was appropriate in order to bring about a significant reduction in costs to borrowers. The Board does not, however, regard that movement as establishing a pattern for future decisions.

The Board will continue to assess prospects for demand and inflation over the period ahead, and set monetary policy as needed to bring inflation back to the 2–3 per cent target over time.